New Economics Papers
on Risk Management
Issue of 2009‒11‒14
nine papers chosen by

  1. A Dynamic Model for Credit Index Derivatives By Louis Paulot
  2. Credit Default Swaps and the Credit Crisis By Stulz, Rene M.
  3. Interaction between market and credit risk: Focus on the endogeneity of aggregate risk By Sokolov, Yuri
  4. Capital Allocation By Erel, Isil; Myers, Stewart C.; Read, James A., Jr.
  5. Quantifying and explaining parameter heterogeneity in the capital regulation-bank risk nexus By Delis, Manthos D; Tran , Kien; Tsionas, Efthymios
  6. Bank Capital Buffer and Risk Adjustment Decisions By Jokipii, Terhi; Milne, Alistair
  7. Evidence on Competitive Advantage and Superior Stock Market Performance By Gjerde, Øystein; Knivsflå, Kjell Henry; Sættem, Frode
  8. Why Did Some Banks Perform Better during the Credit Crisis? A Cross-Country Study of the Impact of Governance and Regulation By Beltratti, Andrea; Stulz, Rene M.
  9. Why Do Foreign Firms Have Less Idiosyncratic Risk Than U.S. Firms? By Bartram, Sohnke M.; Brown, Gregory; Stulz, Rene M.

  1. By: Louis Paulot
    Abstract: We present a new model for credit index derivatives, in the top-down approach. This model has a dynamic loss intensity process with volatility and jumps and can include counterparty risk. It handles CDS, CDO tranches, Nth-to-default and index swaptions. Using properties of affine models, we derive closed formulas for the pricing of index CDS, CDO tranches and Nth-to-default. For index swaptions, we give an exact pricing and an approximate faster method. We finally show calibration results on 2009 market data.
    Date: 2009–11
  2. By: Stulz, Rene M. (Ohio State University)
    Abstract: Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm's financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they been traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the first year of the credit crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and quantify the social gains and costs of derivatives in general and credit default swaps in particular.
    Date: 2009–09
  3. By: Sokolov, Yuri
    Abstract: As shown in the recent BCBS papers market and credit risks could reinforce each other in certain circumstances, meaning the sum of the parts might be less than an estimate of risk that takes into account the interactions between the two. Market risk factors have an ambiguous impact on the firms' repayment conditions because depreciation of domestic currency for instance favors exporters and harms importers. Within the task of a ‘top-down’ aggregation of market and credit risks this contribution presents a general framework to economic capital measurement and active portfolio management splitting exogenous risk factor influence throw different channels. The approach implies an exploiting of banks information about the clients' trade and cash flows related to global economic activity. The way to single out exposures to counterparties belonging to the same pattern of behavioural reactions to the market factors are considered as the bedrock of Factor endogenous behaviour aggregation (FEBA) approach.
    Keywords: integrated analysis of market and credit risk; risk management; endogenous behaviour; concentration risk.
    JEL: G28 G32 G30 E37 G21 E47 G20
    Date: 2009–11–08
  4. By: Erel, Isil (Ohio State University); Myers, Stewart C. (MIT); Read, James A., Jr. (Brattle Group, Inc, Cambridge, MA)
    Abstract: Banks and other financial institutions should allocate capital in proportion to the marginal default value of each line of business, which is the derivative of the value of the bank's default put with respect to a change in the scale of the business. Marginal default values give a unique allocation that adds up exactly. Cross subsidies are avoided if capital allocations are set so that capital-adjusted marginal default values are the same for all lines. We include a series of examples showing how our procedures work and why the allocations are different from allocations based on VaR and the allocations implicit in risk-weighted bank capital requirements. We explain how capital allocations should be "priced" and charged to each line of business.
    Date: 2009–05
  5. By: Delis, Manthos D; Tran , Kien; Tsionas, Efthymios
    Abstract: By examining the impact of capital regulation on bank risk-taking using a local estimation technique, we are able to quantify the heterogeneous response of banks towards this type of regulation in banking sectors of western-type economies. Subsequently, using this information on the bank-level responses to capital regulation, we examine the sources of heterogeneity. The findings suggest that the impact of capital regulation on bank risk is very heterogeneous across banks and the sources of this heterogeneity can be traced into both bank and industry characteristics, as well as into the macroeconomic conditions. Therefore, the present analysis has important implications on the way bank regulation is conducted, as it suggests that common capital regulatory umbrellas may not be sufficient to promote financial stability. On the basis of our findings, we contend that Basel guidelines may have to be reoriented towards more flexible, country-specific policy proposals that focus on the restraint of excess risk-taking by banks.
    Keywords: Capital regulation; risk-taking of banks; local generalized method of moments
    JEL: C14 G38 G32 C33 G21
    Date: 2009–11–10
  6. By: Jokipii, Terhi (Swiss National Bank); Milne, Alistair (Cass Business School)
    Abstract: Building an unbalanced panel of United States (US) bank holding company (BHC) and commercial bank balance sheet data from 1986 to 2006, we examine the relationship between short-term capital buffer and portfolio risk adjustments. Our estimations indicate that the relationship over the sample period is a positive two-way relationship. Moreover, we show that the management of such adjustments is dependent on the degree of bank capitalization. Further investigation through time-varying analysis reveals a cyclical pattern in the uncovered relationship: negative after the 1991/1992 crisis, and positive before 1991 and after 1997.
    Keywords: Bank capital; Portfolio Risk; Regulation
    JEL: G21 G28 G32
    Date: 2009–10–01
  7. By: Gjerde, Øystein (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration); Knivsflå, Kjell Henry (Dept. of Accounting, Auditing and Law, Norwegian School of Economics and Business Administration); Sættem, Frode (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: This article analyzes the value-relevance of industry-based and resource-based competitive advantage in a large sample of firms listed on the Oslo Stock Exchange. We measure competitive advantage by a single variable and perform a new decomposition into its underlying sources. In 1986-2005, the industry-based and the resource-based competitive advantage explain more than 20% of abnormal stock market returns, accumulated over five years. The resource-based advantage is almost four times more important than the industry-based advantage. Differences in both the return and the risk capability of firms’ net assets relative to their industry peers are significant parts of the resource-based advantage, estimated at 60% and 40%, respectively.
    Keywords: Competitive advantage; superior performance; value-relevance of performance metrics
    JEL: L25
    Date: 2009–10–20
  8. By: Beltratti, Andrea (Bocconi University); Stulz, Rene M. (Ohio State University and ECGI)
    Abstract: Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy, and so did banks from countries with stronger capital supervision and more restrictions on bank activities.
    Date: 2009–07
  9. By: Bartram, Sohnke M. (Lancaster University and SSgA); Brown, Gregory (Unviersity of North Carolina at Chapel Hill); Stulz, Rene M. (Ohio State University and ECGI)
    Abstract: Using a large panel of firms across the world from 1991-2006, we show that the median foreign firm has lower idiosyncratic risk than a comparable U.S. firm. Country characteristics help explain variation in the level of idiosyncratic risk, but less so than firm characteristics. Idiosyncratic risk falls as government stability and respect for the rule of law improve. Idiosyncratic risk is positively related to stock market development but negatively related to bond market development. Surprisingly, we find that idiosyncratic risk is generally negatively related to corporate disclosure quality. Finally, idiosyncratic risk generally increases with shareholder protection. Though there is evidence that R[superscript 2] increases with creditor rights and falls with the quality of disclosure, these results are driven by the relations between these variables and systematic risk rather than by the impact of these variables on idiosyncratic risk.
    Date: 2009–04

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